Download The Impact Of Corporate Governance On The Growth And Development Of Small And Medium Scale Enterprises (Smes) In Nigeria

THE IMPACT OF CORPORATE GOVERNANCE ON THE GROWTH
AND DEVELOPMENT OF SMALL AND MEDIUM SCALE
ENTERPRISES (SMEs) IN NIGERIA
By
Kabiru Dandago Isa
PhD, ACA, ACTI, MNES, MNIM
Professor of Accounting and Chair, Bayero Consultancy Services Unit,
Bayero University, Kano-Nigeria
[email protected], +2348023360386
and
Azende Terungwa
M.Sc , MBA, B.Sc.
Lecturer in Accounting and Finance,
Department of Accounting, Benue State University, Makurdi-Nigeria
[email protected], +2347037719881
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THE IMPACT OF CORPORATE GOVERNANCE ON THE GROWTH AND DEVELOPMENT
OF SMALL AND MEDIUM SCALE ENTERPRISES (SMEs) IN NIGERIA
Abstract
This study assesses the financing option available to Small and Medium Scale Enterprises (SMEs) in
Nigeria, using Benue and Nasarawa States as case study. Mean scores and standard deviation were
used to present and analyze the primary data obtained via questionnaires. Correlation was used to
substantiate whether there is similarity in the inherent identified problems of each financing option.
Simple percentages combined with mean scores were used to test hypothesis one while Chi-square was
used to test hypothesis two. The result shows that SMEs are significantly financed by informal sources of
finance than the formal sources of finance. Even SMEEIS, as a seemingly more organized formal
financing option, has not made any significant impact towards SMEs growth in Nigeria. Corporate
governance has been identified to be lacking in our predominant SMEs which is why their funding
problem still subsists. The major recommendation is that Capacity building and sensitization
programmes for all registered SMEs should be put in place by government to train them on the basics of
corporate governance mechanisms needed to grow the enterprises to the highest level possible for the
benefit of the Nigerian economy as a whole. Both the government and the banking sector should
mutually agree on a credit guaranteed scheme strategy that will incorporate a risk-sharing arrangement
as a way of encouraging the banks to channel funds to the SMEs sub sector for their growth and
development which would translate into the national economic growth and sustainable economic
development of Nigeria.
Keywords:
Small and Medium Scale Enterprises, Formal and Informal Financing Option, Risksharing, Sustainable Economic Development
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1.0
INTRODUCTION
Generally, the United Nation‟s Millennium Development Goals (MDGs) are being pursued in Nigeria in
line with the need to enhance the process of development in the country by making all the basic
amenities of life at the disposal of the masses. Specifically, the present administration of Dr. Goodluck
Ebele Jonathan is of the vision that, by the year 2020, Nigeria would be one among the first 20 largest
economies of the world otherwise called vision 20-20-20. This is achievable if it is premised on a sound
and committed economic policies implementation in the country. It must be emphasized that it is while
attending to small matters that bigger things are created (Sule, 1986). Vision 20-20-20, for example, is
economically a big and remarkable thing, but unless Nigeria attends to smaller economic matters, she
cannot achieve it. There is, therefore, the need to assess the country‟s stand now to see if she is heading
to the right direction in actualizing her dreams.
Small and Medium Enterprises (SMEs) play important roles in the economic growth and sustainable
development of any economy (Ariyo, 2005). They may look small or inconsequential but are actually
the foundation of any economically stable nation. The potential benefits of SMEs to any economy
include contribution to the economy in terms of output of goods and services; creation of jobs at
relatively low capital cost; provision of a vehicle for reducing income disparities; development of a pool
of skilled and semi-skilled workers as a basis for future industrial expansion, among others.
According to NCI (2003), a small-scale industry is an enterprise with total cost (including working
capital but excluding cost of land) above N1.5 million but not exceeding N50 million, with a labour size
of between 11 and 100 workers, while the medium-scale industry has a total cost (including working
capital but excluding cost of land) above N50 million but not exceeding N200 million, with a labour size
of between 101 and 300 workers.
Corporate governance is not a new issue in any economic setting, without excluding Nigeria. Many
purposeful organizations give attention for having a corporate governance system with transparent
disclosure of information concerning the organization as suggested by various corporate guidelines
including agency theory. A given economy is made up of different sub-sectors which however work
together for the development of the economy. Such sub-sector ensures to embrace corporate governance
before its impact can be felt. SME is one key sub-sector of any economy that deserves corporate
governance to be successful. The performance of the SMEs is directly concerned with either good
corporate governance or poor corporate governance. This good corporate governance in SMEs has to do
with properly managing its assets and liabilities which can dovetail into its success or not hence a
systematic risk to the society at large. It is therefore worthy to explore the importance of good corporate
governance mechanism in SMEs.
Kpelai (2009) asserts that SMEs are the engine room for the growth of any developing economy,
because they form the bulk of business activities in developed and developing economies like Nigeria.
Many economies like Canada, Croatia, etc have acknowledged that SMEs are crucial for industrial
restructuring and have formulated national SME financing policies, targeted at developing the subsector. However, the small business‟ contribution to macro-economic development is inhibited by the
fact that they have no, or only overpriced, access to finance institutions and other services (SchneiderBarthold, 2002). More so the accessibility to funds and the cost of raising them have remained issues
limiting the in-capitalisation requirement leading to premature collapse of SMEs (Mambula,
2002).Funding has therefore remained one of the key managerial problems that keep confronting
business enterprises in Nigeria today.
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The two fundamental financing concepts of SMEs, the formal and informal forms of financing, have
been identified by previous researchers, scholars and practitioners (Gelinas, 1998; Aruwa, 2004a). The
formal forms of financing are the ones regulated by the government, while the informal forms of
financing are not so regulated by the government.
To Gelinas (1998) and Aruwa (2004a) among the most popular of the formal sources of financing, are
the commercial banks and development banks for enterprises. The informal sources on the other hand
comprise borrowing from friends and relatives, and cooperative credits. With the availability of these
identified financing options SMEs still have problem of financing.
The problem of SME financing has received the most tremendous research efforts from researchers.
Some notable works in this respect include Aernold (1998), Anic and Paus (1998), Inang and Ukpong
(2002) and Aruwa (2004b). In their findings, four problems in financing SMEs have become recurrent:
the cost of capital; risk; the inappropriate terms on bank loans; and the shortage of equity capital. Over
the years government has enacted various policies and introduced schemes aimed at financing SMEs.
However it is worrisome to note that SMEs up till date are starved of funds and the financing problems
keeps reoccurring. Why this recurrent financing problems of SMEs in the face of the formal and
informal financing options available?
Small and Medium Enterprises Equity Investment Scheme-SMEEIS is a product of formal financial
institutions put in place to finance SMEs through a venture capital financing. This initiative is seemingly
attractive as a reliable formal source of financing for SMEs since it involves all the banks in Nigeria and
the Central Bank of Nigeria monitors the banks to enhance compliance. SMEEIS has failed to solve this
financing problem in Nigeria Aruwa (2004).
The aim of this paper is to critically look at the financing options available to SMEs in Nigeria and to
determine whether the reason for this recurrent funding issue is endogenous of the SMEs with emphasis
on corporate governance. The hypotheses tested in the study are stated in the null form as follows: HO1
SMEs in Nigeria are funded significantly by formal sources rather than informal sources. HO2: An
improvement in the manner in which SMEs are run in Nigeria will also improve their funding.
2.0 AN OVERVIEW OF CORPORATE GOVERNANCE
In most management literature you see, governance is tied to companies and its board of directors
(BODs). Our dominant SMEs are relatively small and may have no BOD but governance is also relevant
to it.BOD appoints management which is different from shareholders. The presence of corporate
governance helps close the gap between management and shareholder or all stake holders. In SMEs,
there may be no BODs but ownership has to be distinct from the enterprise as a way of emphasizing the
Entity principle. It is corporate governance which is the super-set of internal control system and is
defined in the International Auditing Guidelines as “ the whole system of control, financial and
otherwise, established by the management in order to carry on the business of the enterprise in an
orderly and efficient manner, ensure adherence to management policies, safeguard the assets and secure
as far as possible the completeness and accuracy of records” that help close the gap between ownership
of the enterprise and all other stakeholders.
There is need to be a distinction between management of a company and governance of a
company or an enterprise. Basically, the management of an enterprise is all about
running the business efficiently and effectively within the boundaries of the enterprise
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under which it trades. By way of contract, the governance role is not concerned with the
business of running the enterprise per se, but with the directors (owners) giving overall
directives to the enterprise, with control of actions of all concerned in its management
and with satisfying legitimate expectations for accountability and regulation by interests
beyond the corporate boundaries; ‘if management is about running a business;
governance is about seeing it is run properly. All companies need governing as well as
managing’ (Sheikh and Chatterjee, 2000 p.6).
Corporate governance is therefore “the nuts-and-bolts of how a public company fulfills its
responsibilities to investors and other stakeholders” (McRichie, 1997 p.1). SMEs also have stakeholders,
like employees, investors (fund providers) creditors, customers etc. the stakeholders expect the
enterprise to survive, grow and yield returns. It is only when such enterprise is not just run, but run
properly that this expectation will be satisfied.
It must therefore by emphasize that wherever there is „expectation‟, corporate governance is needed
because it is this corporate governance that will close the „expectation gap‟ between those who run the
enterprise and the various stakeholders. To Oboh (2004 p.4), what constitutes the quintessential of
corporate governance is “the effects of the enterprise and power over an enterprise‟s direction, concern
for the effects of the enterprises on other parties and especially the environment and the acceptance of a
fiduciary duty to be accountable”.
Giving the vital role played by SMEs in the economic development of any nation, the sector has wide
range of expectation by its stakeholders; for example, government expect SMEs to survive, grow and be
productive to stabilize the economy, customers expect that the products offered by SMEs should be
there for them whenever they need them, big industries that use the products of SMEs are counting on
them for their production, investors expect SMEs to operate profitably to enhance the security of their
funds. The issue of corporate governance is therefore appropriate for SMEs for the overall interest of the
stakeholders and the economy as a whole.
2.1 THEORETICAL FRAMEWORK AND LITERATURE REVIEW
A well functioning financial system is a key enabler of economic growth. SMEs are an important part
of Nigeria‟s economic growth and development and bank lending is the primary source of external
finance for SMEs. Therefore, it is important that the banking sector responds efficiently and effectively
to the needs of SMEs. According to Ohanga (2005) there are a number of features of lending generally
which potentially could affect the efficiency of the market for lending.
Information Asymmetry is a situation where business owners or managers know more about the
prospects for, and risks facing their business than do lenders. Where information asymmetries exist,
bank lending theory predicts that lenders may respond by increasing lending margins to levels in excess
of that which the inherent risks would require. Bank lending theory also suggests that banks may also
curtail the extent of lending – credit rationing – even when SMEs would have been willing to pay a fair
risk-adjusted cost of capital. The implication of raising interest rates and/or curtailing lending is that
firms will not be able to finance as many projects as otherwise would have been the case. Information
asymmetry is more acute in case of SMEs because their relative size makes them economically
unattractive to banks since they are unable to accurately gauge the level of risk involved in lending to
SMEs (Ohanga, 2005).
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2.2 PECKING ORDER THEORY/HYPOTHESIS OF LENDING
Ohanga (2005) asserts that, from the borrower‟s perspective, if faced with a cost of lending that is above
the true risk-adjusted cost, the borrower will have incentives to seek out alternative sources of funding.
Bank lending theory suggests that, where information asymmetry and moral hazard are prevalent, firms
are likely to fund themselves firstly from retained earnings and then from bank debt rather than issuing
equity. This is referred to as the pecking order theory/hypothesis. The theory further suggests that the
mix of debt and equity should be the cumulative result of hierarchical financing decisions over time.
Evidence around the world indicates that small scale enterprises provide an effective means of
stimulating indigenous entrepreneurship, enhancing greater employment opportunities per unit of capital
invested and aiding the development of local technology (Sule, 1986: World Bank 1995). Through their
wide dispersal, they provide an effective means of mitigating rural-urban migration and resource
utilization. Furthermore, by producing intermediate products for use in large scale enterprises, SMEs
contribute to the strengthening of industrial linkages. These explain the increased interest which
developing countries have shown in the promotion SMEs since the 1970s (Ekpenyong and Nyong,
1992).
Akabueze (2002) asserts that the significance of finance in the drive for economic growth is fairly well
established and generally accepted. For instance, the take-off and efficient performance of any
industrial enterprises, be it small or large, will require the provision of funds for its capitalization,
working capital and rehabilitation needs, as well as for the creation of new investments. Apart from
entrepreneurship, funds are required to bring together the other factors of production – land, labour and
capital – before production can take place. Provision of funds to the industrial sector, particularly, for
the SMEs has, therefore, been of prime interest to policy-makers in both the public and private sectors.
Aladekomo (2003) notes that successive governments in Nigeria have, since the last three decades,
shown great interest in financing of SMEs, by establishing specialized banks and other credit
agencies/schemes to provide customized funding to the sub-sector to enhance growth and stability. In
addition to these, programmes like the Nigerian Directorate of Employment (NDE), Better Life for
Rural Women, Family Support Programme, Child Care Trust, People‟s Bank, National Poverty
Eradication Programme (NAPEP), to mention a few, have been introduced.
The impact of all existing credit schemes to SMEs, in terms of providing funds for meaningful and
sustained development among the SMEs, had hardly been noticeable. These credit schemes either have a
direct or indirect link with banks. The banks by their nature and position in the economy, therefore,
remain the known formal source of finance for enterprises (Agumagu, 2006). It is disheartening to
know that a 2001 World Bank survey on Nigerian firms showed that although 85% of the firms had
relationships with banks, most of them had no access to their credit. This explains why SMEs in Nigeria
represent about 90% of firms in the Nigerian industrial sector on numerical basis but regrettably
contribute as low as one percent to GDP in contrast to countries like Indonesia, Thailand and India
where SMEs contribute almost 40% to GDP (HPACI, 2002).
The failure of most of the schemes and the need for a sustainable source of financing SMEs, therefore,
necessitated the recent Central Bank of Nigeria (CBN) inspired Banker‟s Committee initiative which is
aimed at committing the banking industry to the provision of finance and other ancillary support to the
sub-sector via an equity participation scheme.
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2.3 BANK LENDING AND SMES DEVELOPMENT IN NIGERIA
SMEs are crucial catalysts for economic development (Aruwa, 2006). Banks provide a nation with a
function of pooling scattered resources from surplus to deficit units so as to promote investment
innovation, productivity and consequently growth and development. The banking industry in Nigeria
dominates the financial system (Agusto, 2000). Berger et al (2001) maintains that a well functioning
financial system contributes to investment and economic growth. Every enterprise at its onset, before
standing firm on its feet, needs borrowing. The first place that they need to go and borrow at those times
is the banks.
According to elementary corporate finance theory, an investment project should be undertaken
whenever its net present value is positive. This assumes that the capital outlay is not exhaustive. Firms
do any volume of investment, and so where the firms do not have adequate capital to embark on any
level of investment, there is need for capital borrowing (Mainoma, 2005). This shows that even if an
enterprise is strong and firmly rooted, it still does not stop borrowing, because it can embark on a very
large scale investment more than it currently does, if it can get the required capital. When funding
becomes a major problem for such enterprises, nothing else works. This is because other problems
which emerge later in an enterprise‟s lives that are being tackled as natural problems which come after
its funding. This in turn hinders the growth and development of the economy.
Njoku (2007) postulates that to forestall the imminent capital flight from the real sector to the banking
sector, banks should begin to take second look at the industrial sector in terms of lending operations. He
continues that banks should plough back a large proportion of the money available to them to the real
sector of the economy as long-term loans at rates not exceeding 5%. This he said will encourage
industrialists not only to remain in their present businesses but also to achieve their business expansion
targets.
Small and medium scale enterprises dominate the private sector of the Nigerian economy, but almost all
of them are starved of funds (Mambula, 2002). The persistent lack of finance, for establishment and
operation of SMEs occasioned by the inability or unwillingness of the deposit money banks to grant
long term credit to operators of the real sector of the economy, led to the establishment of development
finance institutions and the introduction of numerous funding programmes for the development of SMEs
in Nigeria. In spite of these institutions and funding programmes, there continues to be a persistent cry
against inadequate finance for the development of the SMEs in the country.
The CBN (2008) shows that commercial and merchant banks loans and advances to SMEs have been
decreasing over the years. The statistics show thus; commercial bank‟s loans to SMEs as a percentage
of total credit decreased from 48.8% in 1992 to 22.22% in 1994. The trend increased marginally to
22.9% and to 25.5% in 1995 and 1996, respectively. There was a sharp reduction from 25% to 17% in
1997, and the decrease continued till it reached 0.2% in the year 2008. Similarly, merchant banks loans
to SMEs as a percentage of total credits reduced from 31.2% in 1992 to 9.0% in 2000 (Akabueze, 2002).
The continuous decrease in commercial and merchant bank‟s loans to small scale enterprises can be
attributed to lack of collateral from the SMEs to secure the loans and the high lending rates from the
banks.
2.4 MAIN SOURCES OF FINANCING SMES IN NIGERIA
The importance of finance to business organisation cannot be over-emphasised. Business finance is
however, not easy to come by especially in respect of SMEs. Yet they require funds from every source
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available to meet their asset needs, working capital needs, and for expansion. According to Ekpenyong
and Nyong (1992), there is wide consensus in Nigeria that government policies are skewed in favour of
the formal sector to the detriment of the informal sector. This skewness is to the great disadvantage of
SMEs in Nigeria since they are more disposed to the funds of the informal sector.
2.4.1 Formal Sources of Financing SMEs: The commercial banks, merchant banks, and development
banks provide the formal sources of finance to SMEs. The financial system in Nigeria is not in short
supply of liquidity, but banks have been very reluctant to grant loans to SMEs, which they regard as a
high-risk sector. Most of the banks would rather pay the penalty imposed for not meeting the minimum
exposure to preferred sectors of the economy than actually run the risk of being exposed to them.
According to Ojo (1984), the sources of investment finance for SMEs include owner‟s savings and
assistance from banks, government institutions, local authorities, co-operative societies, relatives and
friends, and moneylenders. The study shows that almost all the funds came from personal savings
(96.4%) with about 3% from the informal sector and 0.21% from the formal financial institutions. This
trend is further established by a 1983/84 study by the Nigerian institute for Social and Economic
Research (NISER). NISER findings show that about 73% respondents raised their funds from personal
savings, while only about 2% obtained their funds from the formal financial institutions.
2.4.2 The Small and Medium Industries Equity Investment Scheme (SMIEIS) Fund: In Nigeria,
the formal financial institutions have been organised to finance SMEs through venture capital financing
in the form of a SMIEIS fund. This was in response to the Federal government‟s desire to promote
SMEs as vehicles for rapid industrialisation, sustainable economic development, poverty alleviation and
employment generation. Venture capital financing supplements or takes the place of credit facilities that
the conventional banks are unwilling to give. The provider of the funds may initially part with the funds
as a loan, but specifically with the idea of converting the debt capital into equity at some future period in
the enterprise. The return from such investment should be high to compensate for the high risk.
Venture capital may be regarded as an equity investment where investors expect significant capital gains
in return for accepting the risk that they may lose all their equity (Golis, 1998).
The Nigerian government‟s version of venture capital financing of SMEs -SMIEIS, requires all licensed
banks in Nigeria to set aside 10% of their pre-tax profit for equity investment and to promotion of small
and medium-scale enterprises. The goal is to reduce interest rate burden and other financial service
charges imposed under normal bank lending.
According to Sanusi (2004), a breakdown of the SMIEIS fund investment by sectoral distribution shows
that 68.82% went to the real sector while service related investment accounted for 31.18%. This, he
noted, is a sharp reversal from the initial trend recorded under the scheme. The Bankers Committee have
allocated the investment of banks with respect to the fund as 60%, 30%, and 10% of their fund in
core/real sector, service-related and micro-enterprises respectively. Analyzing the geographical spread
of the SMIEIS fund, Sanusi (2004) reported that Lagos-based investments have gulped 56.63% of the
fund, and Abuja and 18 states received the balance 43.47%.
The point is about the model of growth of SMEs and financing options available with respect to
corporate governance. Golis (1998) submit that venture capitalists do not seek enterprises on the start-up
and survival stage but only in the stability and rapid growth stages did the venture capitalists appear
which goes to show their fear because of the risk associated with the early stages. Yet the method of
financing remains a critical success factor for SMEs.
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To be eligible for equity funding under the scheme, a prospective beneficiary shall: i). Register as a
limited liability company with the Corporate Affairs Commission and comply with all relevant
regulations of the Companies and Allied Matters Act (1990) such as filling of annual returns, including
audited financial statements; ii).Comply with all applicable tax laws and regulations and render regular
returns to the appropriate authorities (Bankers Committee Revised, 2005).
Aruwa (2005) laments that, given the developmental stage of Nigeria‟s dominant SMEs; it is difficult
for them to meet any of these requirements. Consequently, SMEs in Nigeria do not have the capacity to
access funds from SMEEIS.
With corporate governance, our Nigerian dominant SMEs will position themselves as good investment
opportunities and become attractive for all available schemes to part with their funds to them.
3.0 METHODOLOGY
This study is designed to look at financing options available to SMEs in Nigeria and to identify the
factors that militate against the exploration of the formal sources of financing such as SMEEIS. The
study also wishes to further establish that corporate governance can lesson their risky nature and
package more attractive for investment. To achieve this purpose, the survey research design and an
empirical method making use of Chi-square and correlation was used. Chie-square was used to test
hypothesis concerning issue of accessibility of SMEEIs funds. Correlation was used to substantiate
whether there is similarity in the identified problems of each financing option. Mean scores using 5
point likert scale was used to present and analyze the collected data via questionnaire. Simple
percentages were also used to put together the data concerning responses about the financing mix of
sampled SMEs. The questionnaire is used to obtain the views of the owners of SMEs on the operations
and impact of SMEEIS.
The population of this study is made up of 700 SMEs with a minimum of five year life span operating
within Benue and Nasarawa States. The study‟s sample size is 88 SMEs made up of 43 from Nassarawa
state divided into 30 small-scale enterprises and 13 medium-scale enterprises. Similarly 45 SMEs were
drawn from Benue State divided into 34 small-scale enterprises and 11 medium-scale enterprises.
Unfortunately only 40 completed questionnaires were returned from Nasarawa made up of 28 smallscale enterprises and 12 medium-scale enterprises. Similarly, only 44 questionnaires were returned from
Benue State made up of 33 small-scale enterprises and 11 medium-scale enterprises. The sample size
was, therefore, limited to 84 SMEs.
The research sample was computed using the following formula, allowing 10% tolerable sample error.
Sample Formula (n) = N/1 + N(e)2 , where n is the required sample size, N is the research population,
and e is the tolerable error in judging the population. Primary data were obtained using questionnaire
designed for SMEs and financing institutions separately and structured interview instruments. The
questionnaire employs likert-scale measures, a fifteen likert-like scale having four response categories
labeled or weighted as strongly agree (4), agree (3) disagree (2) and strongly disagree (1).
4.0 DATA PRESENTATION, ANALYSIS AND INTERPRETATION
4.1 ANALYSIS AND INTERPRETATION OF RESPONSES ON FORMAL FINANCING
The responses from the questionnaire administered in respect of formal financing sources available to
SMEs in Nigeria are presented and analyzed below:
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Table 1: Mean Scores on Formal Financing Sources
Variable
Sample Mean
Standard
Minimum
Maximum
size
Deviation
Score
Score
Formal finance as main
84
1.34
0.71
4.00
1.00
source of Capital
Bank loan
84
1.33
0.69
4.00
1.00
Second-tier
Security
84
1.00
1.18
0.00
0.00
market (SSM)
SMEEIS
84
1.20
0.57
4.00
1.00
Others
84
1.19
0.50
3.00
1.00
Combined Mean/SD
score
84
6.06
3.65
6.06 < 12.5
Source: Field data computation (November, 2009)
In the analysis presented in table 1, none of the formal financing variables meet the cut-off mean of 2.5
for individual item. Respondents perceived that the utilization rate of formal financing sources among
the SMEs sampled was low. The overall perception of formal financing sources that emerge from this
analysis, therefore, is that there is low utilization rate of formal financing sources by SMEs in Nigeria
given that the computed overall mean score of the variables (6.06) is less than the sections cut-off mean
of 12.5. The standard deviation (3.65) shows that there is no much disparity in the respondents‟
perception as evidenced in the mean scores the formal financial options are relatively organized and
would want to deal with an enterprise that is as well organized. Corporate governance can portray an
SME as organized in the eyes of stakeholders especially fund providers to enable them secure the
desired funding. This low utilization of this option could be as a result of poor governance hence a risky
venture.
Table 2: Mean Scores on Informal Financing Sources
Variable
Sample Mean Standard Minimum Maximum
size
Deviation
Score
Score
Informal finance as main
84
3.86
0.48
1.00
4.00
source of Capital
Personal Savings
84
3.60
0.82
1.00
4.00
Cooperative Credits
84
3.91
3.39
1.00
4.00
Loans from
84
1.96
1.28
2.00
1.00
Friends/Relatives
Ploughed-back profits
84
1.35
0.87
2.00
4.00
Combined Mean/SD score
84
14.68
6.84
14.68 > 12.5
Source: Field data computation (November, 2009)
Table 2 depicts a favorable perception on utilization of informal financing sources than the data
presented in Table1. The cooperative credit has the highest mean score of 3.91. What is significant in the
table is that the SMEs‟ mean score of 14.68 on informal sources of finance is higher than the section‟s
cut-off mean of 12.5. The disparity in perception as indicated by the standard deviation is low.
Comparatively, the mean scores recorded for formal sources of finance in Table 1 was 1.34. This is less
than the mean score of 3.86 recorded for informal sources of finance (Table 2). This is interpreted that
informal sources of finance are more available and more utilized by SMEs in Nigeria than the formal
sources. Relations, cooperative credits are all from people within immediate or extended family cycles
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their based on “loose” trust. In an organize setting, business is run on lay down rules not loose trust. It
could be for this reason that this informal financial option is embraced more by SMEs in Nigeria.
Table3: Mean Score on Financing Problems
Variable
Sample size Formal Sources
Cost
84
2.02
Accessibility
84
1.31
Collateral
84
3.71
Awareness
84
3.38
Risk (others)
84
2.57
Combined Mean Scores
13.99 > 12.5
Source: Field data computation (November, 2009)
Informal Sources
1.03
3.71
1.62
2.10
1.36
9.82 < 12.5
The study investigated what could be the likely financing problem that brought about deviation in the
use of both formal and informal financing sources. Table 3 provides the analysis along five variables on
likert scale measures. The formal sources of finance combined mean score (13.99) on the cost,
accessibility to source of finance, collateral security requirement, awareness of existence of sources of
finance and the risk inherent in use is higher than the cut-off mean whereas the cut-off mean on informal
sources, which is within acceptable mean score (9.82 < 12.5). However, the informal sources of finance
mean score on awareness is lower than that of the formal sources. This could mean that the existence of
formal sources of finance like SMEEIS is not to the knowledge of most SMEs.
A further test of correlation between the mean scores of formal and informal sources of finance shows
negatively- correlated relationship of -0.5000 on the variables of financing problems. This is shown in
Table 4 below:
Table 4: Correlation Coefficient of Financing Problem Variables
Variable
Mean
Formal Sources
Informal Sources
Cost
2.02
1.03
Accessibility
1.31
3.71
Collateral Security
3.71
1.62
Awareness
3.38
2.10
Risk (others)
2.57
1.36
Correlation Coefficient (r)
-0.5000
Source: Field data computation (November, 2009)
It is no doubt that there is a relationship between formal and informal sources of finance as far as SME
financing is concerned. The calculation of correlation coefficient (r) revealed an average negative
relationship between these variables. This could be explained that accessibility may be a problem more
of the formal sources than of the informal sources. Similarly, the level at which collateral is demanded
in formal sources is not the same as in an informal source. A positive correlation coefficient would on
the other hand mean, the more collateral is needed in formal source, the more it is needed also in an
informal source. The negative correlation therefore, shows that the variables move on average in the
opposite direction.
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4.2 TEST OF HYPOTHESIS 1
Table 5: Sampled SME Financing Mix
Source of
Small Enterprise
Medium Enterprise
Finance
(percentage of Total
(percentage of Total
Capital)
Capital)
Formal Sources
32
30
Bank loans
04
24
NDE/NACRDB
25
00
SMIEIS
03
05
SSM
00
00
Equipment Leasing
00
01
Informal Sources
68
70
Personal Savings
20
23
Cooperative Loans
31
33
Loan from friends/ Relatives
15
12
Others
02
02
Source: Interview Questionnaire Responses (November, 2009).
Table 5: depicts the percentage of the formal and informal component sources of financing in the capital
structure of the SMEs. The results in the table show that the SMEs benefited more from informal
sources than the formal sources of finance. The informal source of finance makes up 68% of small
enterprise‟s capital and 70% of medium enterprise‟s capital respectively. None of the enterprises
secured capital from the Second-Tier Security Market (SSM). Cooperative credits constituted the
highest contribution to the capital of these enterprises accounting for 31% and 33% in the small and
medium enterprises respectively.
4.3 TEST OF HYPOTHESIS 2
HO2: An improvement in the manner in which SMEs are run in Nigeria will also improve their funding.
Chi-square was used to test this hypothesis. The data used for the testing are the responses obtained
from the research Questionnaire. The summary of the responses are presented in the table below:
Table 6: Responses from Question 17 of the Questionnaire
Respondents
Responses
Poor corporate Other
governance
reasons
Bank managers
56
5
Senior staff Ministry of
20
3
Commence and Industry
Total
76
8
Total
61
23
84
The above shows that a total of 56 Bank managers from Nasarawa and Benue States lamented that poor
corporate governance of SMEs are responsible for their reluctance in funding SMEs, while five other
managers from the two states attributed their reluctance to other reasons. In the same vein, a total of 20
senior staff of the Ministries of Commence and Industry from the two state under which SMEs are
registered and monitored confessed that poor corporate governance is prevalent in the predominant
SMEs while three of these category of staff from this ministries gave other relative reasons why funding
12
is still a problem for most SMEs. On the whole 76 Bank managers from the two states are of the opinion
that the absence of corporate governance in SMEs in Nigeria is the reason for their reluctance in funding
them, while 8 Senior staff of the ministries under which SMEs are registered and monitored are
affirmatively said poor corporate governance is one key reason for the persistent funding crises of SMEs
in Nigeria.
If the calculated chi-square (X2) is greater than the table value (critical value), the difference is
significant, and so the null hypothesis is rejected. But if X2 is less than the table value, the difference is
insignificant, and so the null hypothesis is accepted.
The critical value of X2 at 0.05 1df is 3.841. The calculated value in this case 0.73 which is less than the
critical value. Therefore the difference is insignificant and so the null hypothesis, which states that
conditions for accessing SMEEIS funds are beyond the reach of most SMEs, is accepted.
4.4 DISCUSSION OF FINDINGS
Table 5 shows that bank lending to small-scale enterprises in Nigeria was just four percent of the total
finance of the sector during the period under review. This is at variance with the pecking order theory or
hypothesis which implies that banks should lend to SMEs where they have exhausted their retained
earnings to finance their investment. SMEs by their nature cannot raise substantial internal finance. It,
therefore, becomes necessary for them to seek bank lending to bridge the gap between their retained
earnings and their potential investment outlay. The way banks looks at the SMEs is therefore very
important in this circumstance.
Table 5 also shows that bank lending to medium-scale enterprises was 24% of the total finance of the
sector, which is relatively higher than the figure for small-scale enterprises. This is also at variance with
the pecking order theory. Going by the theory, it is to be expected that small-scale enterprises should
get more bank loans than medium-scale enterprises since they can raise more internal finance than
small-scale enterprises. It could, therefore, be inferred from the above that banks in Nigeria only lend to
enterprises that show some sense of maturity in the way their affairs are run and have high potentials to
repay loans. With this type of philosophy, they can hardly support small-scale enterprises until there is
evidence of improvement in the way they are run. Since SMEEIS comprise banks, this behavior of
banks can be rightly said to represent the behavior of SMEEIS.
The factors that have favored informal financing of SMEs in Nigeria over the formal financing were cost
of finance, ease of accessibility, nature of collateral security and risk mitigation capacity. It is evident
from the study that it costs SMEs less interest charges on borrowings from informal sources than
prevailing rates in the formal sources. Whereas accessibility to informal sources of finance was less a
problem, it was still difficult for SMEs to access funds from the formal sources because of stringent
collateral security requirement and inadequate risk mitigation schemes for the formal sources of finance.
In the informal sources, individual‟s reputation and community acceptance or cooperative society
membership were sufficient to access the funds for business purposes.
Corporate governance is not only for big companies. SMEs also have stakeholders like fund providers,
employees, the government etc. wherever there are stakeholders, an organization must run in a manner
to giver clear information on its operations. Decisions must be for the best interest of all stakeholders
hence growth, development and sustainability of such organizations and the economy at large.
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5.0 CONCLUSIONS AND RECOMMENDATIONS
It is obvious that a dynamic SME sub-sector is needed for Nigeria to attain industrialization and
sustainable economic development and for its Vision 20-20-20 to be achieved. This subsector is,
therefore, vital and imperative for the actualization of Nigeria‟s vision. The observed weak performance
of notable formal financing options, like SMEEIS, occasioned by lingering constraints should, however,
be seen as a big challenge for policy makers in the country. This study hereby reveals the following
major findings:
 The financing mix of SMEs in Nigeria is predominantly from informal sources of finance. This
is shown by the use of this option more than the formal sources by the SMEs. Cooperative credit
ranks highest in this category while the second-tier security market (SSM) is left un-patronized.
 A comparative analysis of the inherent problems of the formal and informal sources of finance to
SMEs shows that the formal sources are inherently more problematic to SMEs in Nigeria than
the informal sources.
 Most of the banks in the country do not pay sufficient attention to the development of SMEs via
financing because of their poor corporate governance.
 The conditions for assessing SMEEIS funds is not that it is too stringent but there are normal
conditions that any well managed business outlet should satisfy.
The following recommendations are hereby made in response to the above findings:
 Banks, by their nature and in line with their objective, do try to minimize risk; while SMEs, on
the other hand, are inherently risky. Consequently, the government and the banks should
mutually agree on a credit guarantee scheme that will incorporate a risk-sharing arrangement as a
way of encouraging banks to channel funds to SMEs.
 Capacity building and sensitization programmes for all registered SMEs should be put in place
by government to train them on the basics of corporate governance mechanisms needed to grow
the enterprises to the highest level possible for the benefit of the Nigerian economy as a whole.
 Diversification of financial support for start-ups, growing and successfully operating SMEs will
significantly contribute to the creation and development of SMEs. Start-ups, growing and
successful SMEs should get 50%, 30% and 20%, respectively of whatever financial support are
available for SMEs.
 There should be steady programme on radio and television in an attempt to report to the whole
world the efforts of Nigerian SMEs in improving their general conduct so that their maturity can
be assessed.
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